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Taxation of Intellectual Property – Recent UK Reform

14 Sep 2011

The introduction of a patent box regime taxing relevant profits at 10% in the UK has brought renewed focus to the management of UK intellectual property. Proposed reform to the UK controlled foreign companies (CFC) legislation, as referenced in July's Taxand's Take, has also necessitated a review of intellectual property management and the tax implications of centralised holding companies to fund manage and exploit intellectual property.

Taxand UK details the proposed changes to UK legislation impacting intellectual property and explains why it is critical time for multinational groups with UK operations to consider the new guidance and compliance obligations - it is also a critical time to review the planning opportunities afforded by the new guidance.

The key areas of opportunity for multinationals are:

  • increased clarity in relation to the functions of a centralised IP management company
  • increased clarity in relation to the exemptions for IP management companies from the CFC regime
  • a reduced rate of tax for UK-registered patents

Increased clarity in relation to the functions of a centralised IP management company
The last decade has seen a barrage of dispute resolutions with the UK Tax Administration relating to the commercial activities of an IP management company and sustainability of tax planning by housing IP in a low-tax jurisdiction.

Proposed guidance has confirmed some useful do's and don'ts, and the do's are set out (verbatim) here to demonstrate that the UK Tax Administration has taken on board some of the historic arguments put forward:

  • The IP is transferred offshore as part of a trade with the associated activities and assets
  • There is real substance in the transferee jurisdiction and employees with the necessary expertise, who previously had nothing to do with the IP, actually manage and develop the IP transferred
  • The transfer is of IP which the CFC is better placed to actively manage and develop because of the availability of local expertise specific to that IP
  • The majority of the value adding activities connected with the management and development of the IP happen in the CFC and the expenses are incurred there
  • Cash tax is paid on exit of the IP
  • Quality control takes place in the CFC

Increased clarity in relation to the exemptions for IP management companies from the CFC regime
Historically, IP management companies in low-tax jurisdictions were over-reliant on the motive test (now the general purpose exemption). Whilst this test is still of great value and use, the revised territorial business exemption (TBE) has provided additional clarity over exemptions from the CFC regime for commercial, regional IP management companies.

It is important to demonstrate that no more that 50% of expenditure relating to IP is with related parties in the UK and that no more than 20% of income involving exploitation of the IP is from the UK. In most cases, a regional IP management company with IP exploited in a number of locations will satisfy these tests and this will facilitate IP planning opportunities.

A reduced rate of tax for UK-registered patents
There is increased incentive to undertake a portion of R&D in the UK relating to patents that could be registered and exploited. Income from such registered patents will be taxed at 10% from 2013 as opposed to the statutory rate of 26%.

Taxand's Take

Running an in-house diagnostic of opportunities:

1. Catalogue all existing and developmental-stage IP.

2. Consider in-house legal and commercial fact pattern for holding IP in existing jurisdictions.

3. Split this IP into (i) registered (e.g. existing patents), (ii) capable of being registered (e.g. patents that have not been applied for) and (iii) not capable of being registered (e.g. non-UK IP and non-patentable UK IP such as trade names etc.).

4. Create high-level P&Ls in relation to each category of IP specified above and apply relevant tax rates (10% for UK registered, 26% for non-UK registered, blended rate for balance of IP depending on key locations, losses brought forward, etc.).

5. Calculate the proportion of UK and non-UK IP expenditure and income (for purposes of considering application of the territorial business exemption).

This is a global or regional exercise that will support planning in any relevant jurisdiction. Many European jurisdictions have similarly attractive IP management regulations designed to encourage business - therefore it is possible to design a tax-effective structure that sits in parallel with commercial operations.

Your Taxand contact for further queries is:
Shiv Mahalingham
T. +44 207 715 5234

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